Pain ahead from high dollar

Today will mark the 100th day that the Australian dollar has closed above $US1 since it was floated almost three decades ago. A strong dollar has become the new normal.

At the close of New York trading tonight, the Australian dollar will have closed above parity with the greenback for the 100th time as a floated currency.

Market economists and analysts are now modelling revenue and costs based on a strong currency and, privately, federal Treasury and the Reserve Bank of Australia agree a high dollar is here to stay.

It means substantial structural change to the local economy and that’s painful, said
Bernie Fraser
, governor of the RBA from 1989 to 1996.

“[Floating the dollar] was the single most important economic policy of the last 60 years," he says. But he is concerned about the damaging effects of the dollar at such high levels. “The exchange rate does facilitate restructures, but governments have to watch out for protecting other interests as well. Because these restructures might favour a particular part of the economy."

The dollar was trading at about $US1.07 on Friday. It breached parity in October last year, fell, then broke through again on November 10.

On May 2 this year, it hit a post-float high of $US1.1012.

Since its float in 1983, the Australian currency has spent most of its time between US75¢ and US80¢. In April 2001, it fell to a low point of US47¢ and has only spent 1.4 per cent of its time above parity.

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In trade-weighted terms – which measures the dollar against the currencies of Australia’s trading partners – the unit is about 40 per cent above its post-float average. Its current position is uncharted territory for economists, companies, policymakers and consumers and with consensus being that the dollar will stay above parity, economic resources need to be reallocated.

Treasury and the Reserve Bank believe the current realignment of the Australian economy towards the mining industry and away from other sectors is the biggest change in the Australian economy since the 1980s.

This time around, the Australian dollar is exerting the most pressure on the traded sector, particularly tourism, education and domestic manufacturing, which are unable to compete with cheaper exports.

The mining sector, booming as a result of demand from China, is relatively immune to the higher Australian dollar as the products it sells are denominated in US dollars.

“What the exchange rate does is redistribute some income to consumers and importers," says former senior Treasury official and director of forecaster Outlook Economics, Peter Downes.

“But it has a negative effect on import-competing sectors."

Downes believes that for every 10 per cent appreciation in the dollar, national business activity is reduced by about 1 per cent.

“So the 40 per cent appreciation we’ve had since early 2009 is a huge shock to the economy which is offsetting the positive shock that is coming from the terms of trade and mining investment boom," he says.

Japan underwent a similar restructuring during a period in the 1990s, when the yen was particularly strong. Between 1990 and 1995, the yen appreciated by 50 per cent against the greenback.

Although the sophisticated technological businesses that Japan is now famous for emerged stronger, the net effect on the country’s economy was negative, says Richard Koo, chief economist at the Nomura Research Institute in Tokyo. “We lost lots of industry to south-east Asia and China. There was an exodus towards cheaper labour. Then when imports were liberalised after 1995, Japanese companies started to build things outside Japan . . . Imports came flooding in, which brought prices down dramatically."

There is a growing rumble of discontent about the damaging effect the high dollar is having on industry.

Australian Industry Group chief executive
Heather Ridout
has said the “punishing effect" of the strong Australian dollar “will necessitate action from the government, because there’ll be potentially a lot of restructuring that’ll end up in job losses".

The RBA is the only body in Australia with the power to intervene in currency markets, and it does so frequently to cover government positions.

The bank has previously only actively intervened to affect the value of the currency when it has been falling, and has said it makes such decisions based on a belief that the dollar’s valuation is out of line with fundamentals. Fraser judges an intervention as unlikely at present. “The RBA will make decisions of that kind as and when it feels it can make the best impact or when it needs to make an impact," he says.

“Exchange rates are driven by fundamental factors and by speculative factors . . . that cause markets to overshoot in both directions, and the RBA might contemplate doing something about it if it judges they are getting out of hand."

Koo extends a warning to Australia not to be content to rely on the mining industry for a buffer against the strong dollar.

“If you have lots of natural resources, consider yourself lucky. But it’s tough for the manufacturers.

“People might have great ideas, great products, but even though you’re doing the very best in the world, you end up uncompetitive because of the exchange rate," he says.

“Then when the tide changes, you might realise that you’ve been a little lazy."